Sharp rate hikes will raise economic risks

The United States Federal Reserve's pivot to hiking the Fed funds rate by 75 basis points on Wednesday to a range of 1.5 to 1.75 per cent reflects its heightened urgency to tame inflation. But it also raises the risks of more financial market turmoil, a sharper economic slowdown and even recession. Having earlier telegraphed a 50-basis-point rate hike in June, the Fed decided on a more aggressive stance after the latest US consumer price inflation readings, which came in at 8.6 per cent in May, year on year - significantly higher than expected. Fed officials have also signalled that they have embarked on a path of steeper rate hikes going forward, projecting the Fed funds rate at 3.4 per cent by the end of this year, rising to 3.8 per cent a year later compared with a projection of 2.8 per cent in March, which suggests at least one more 75-basis-point hike.

The Fed has also started quantitative tightening, whereby it will stop reinvesting the proceeds of its bond portfolio, leading to even tighter financial conditions. But even these measures may not succeed in taming inflation, which is driven mainly by supply-side shocks such as high energy and food prices, supply chain disruptions and labour shortages. With Russia's war on Ukraine still raging and lockdowns in China persisting, there is even a risk of inflation rising further.